Welcome to the forum, Bowen B!
What sort of machine and engine is this?
It looks like damages from the cavitation effect. It occurs on the outside of the cylinder wall and the wall is slowly being pitted, deeper and deeper, and a hole is made. The coolant is then getting into the cylinder through the hole/s. This article explains it:
Find more by searching the Interwebs for "diesel cylinder cavitation".
If you pressurize the cooling system, you will see coolant coming out of the cavities.
I can not determine if there is a cylinder liner or not. If here is a liner, that could be replaced with a new one.
If there is no liner/sleeve you need to rebore the cylinder and put a sleeve in it. Hopefully, the block is healthy enough for such an operation. You need to consult an expert to find out what is possible to do.
Why do you think the engine is burning oil? If it is because of excessive smoke from the exhaust, you may have mistaken the smoke for being from oil instead of water (coolant). It can be hard to determine, but oil smoke is usually a bit more blue in color than water smoke. The inside of the cylinder would not look that clean if you had been burning engine oil.
The knocking is probably because of the coolant that gets into the cylinder. It can not be compressed like the air, it rather expands when it boils, so it makes a physical obstacle for the piston and that gives the knocking sound.